Veracyte, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Veracyte, Inc. is a global diagnostics company that develops tests for various diseases, primarily focusing on cancers, leveraging advanced genomic and proteomic technologies to guide diagnosis, treatment, and patient management decisions.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

Veracyte operates in the precision diagnostics space, offering tests that provide clinically actionable information to physicians, enabling more informed treatment decisions for their patients. The company’s strategy revolves around the commercialization of diagnostic tests that improve patient outcomes while reducing unnecessary interventions. They primarily focus on oncology and pulmonology and are moving further into other areas with significant medical needs.

Revenue Distribution:

Veracyte’s revenue is derived from a combination of product and services revenue, that may be a mix of one time sales, recurring or recurring sales from one time sales. This distinction is vital for understanding the predictability and sustainability of its revenue streams.
In addition to test revenue, the company also recognizes collaborations and other revenue that mainly consists of licensing its intellectual property and partnering with other companies. However, these amounts are small compared to the test revenues.

Industry Trends & Competitive Landscape:

The diagnostic industry is marked by a growing trend toward precision medicine, where treatment decisions are tailored to individual patient characteristics, often informed by genomic and proteomic analysis.
Competition exists from larger diagnostic companies that have scale advantages, and a smaller, more specialized diagnostics companies.
Barriers to entry, especially in specialized testing, are high due to high development costs, significant regulatory hurdles, and the need for specialized expertise.
Increasing prevalence of data-driven and AI-backed diagnostics that improve the accuracy and efficacy of these tests.

What makes VCYT Different?

Proprietary Technologies: Veracyte leverages its proprietary genomic and proteomic technologies to develop differentiated diagnostic tests, giving it edge over generic diagnostic labs.
Focus on unmet needs: The company focuses on developing solutions for cancers and other diseases that face challenges in diagnosis and treatment.
Data and AI: The company utilizes machine learning and proprietary algorithms to improve the results of its diagnostic tests, providing more accurate and actionable information to physicians.
Multiple Platforms: The company has developed multiple platforms that can be used for the diagnosis of a diverse group of diseases.

Financials

VCYT’s financial performance is showing improvement as the company transitions from a commercializing/high growth phase to a more stable and profitable business. It has had positive trends of improvements but certain concerns are still present.

Revenue:

Revenue has shown growth over past few years, as new tests gain traction, with 2022 revenue at $273 million and revenue for the 9 month period to Sep 30, 2023 of $277 million, a growth of over 25% over the first 9 months of 2022. They have also seen an increase in test volume year over year, also driven by new tests and acquisitions.
However, their revenue is not consistently growing quarter over quarter which indicates a level of volatility and unpredictability.
Revenue is expected to slow to 15% for 2024.

Gross Margin:

The company boasts excellent gross margins, typically around 60%. This high level indicates that the company is capable of producing highly specialized tests that has a wide economic moat surrounding its business. It is important to note that margins are more sensitive to volume in the commercial sector than in the pharmaceutical sectors.

Operating Expenses:

Operating expenses are high, particularly in sales & marketing and research and development, which is a result of the nature of business the company is involved in, namely that it requires a high degree of marketing and R&D for its cutting edge tests.
Total operating costs (including R&D) in the first nine months of 2023 were 29% higher than that same period in the previous year. Sales and marketing costs were approximately 24% higher and G&A expenses increased by over 20% in the first nine months.

Profitability:

Although the top line has seen improvement, they are still not consistently profitable on their overall operations. In the 9 month period in 2023, they had a net loss of $71 million as opposed to a net loss of $47 million for that same period in 2022.
While they had a positive Q4 2022, they have had negative earnings in all the subsequent quarters in 2023.

Recent Developments, Concerns and Management Outlook:

In a Q2 earnings call, management emphasized that Veracyte’s core business is growing well, and as they have made the required investments, their R&D costs will be lower going forward. They emphasized a focus on cost controls.
Veracyte is expanding internationally and is now receiving revenue from France and Ireland. The company also emphasized that its test performance and revenue has not seen any material impact from AI technology, which is a positive sign given how tech stocks are being highly impacted by AI. They had also implemented machine learning into their testing processes that have reduced human interventions and has increased efficiency and lowered costs.
The company expects the second half of 2023 to be much stronger than the first.
In a recent presentation, the CEO stated that 75% of their revenues came from 7 tests and that the rest is coming from new products. He further said that they plan to launch new products that will create a much better market share for their products. Management reiterated a focus on generating a positive return in free cash flow and to manage expenses to be disciplined on the same.
One concern that was highlighted in recent earnings calls and the latest 10-Q document is the impairment of intangibles by $7.2 million, which may indicate management has overpaid during acquisitions and other intangible investments.

Moat Rating: 2/5

Justification: VCYT has some competitive advantages, however, they are not very wide or strong.
Intangible Assets: The company possesses proprietary technologies which provide them an edge over direct competitors. Also, these proprietary technologies are hard to duplicate, and the expertise required to do so is not very readily available.
High Switching Costs: Customer stickiness/lock-in is a factor as many of the hospitals require to be on their network and use their products to ensure patient data is protected and secured which increases customer dependence.
Not so strong Network effects: A small degree of network effects may exist as an increasing number of physicians use the platform. But the strength of this effect in ensuring long-term profitability is weak.
No Cost Leadership: The company doesn’t have any kind of cost advantages. It may be a price leader in some regions, but other players will quickly adopt similar technology to close that gap.

Risks to the Moat and Business Resilience: * Technological Disruption: As a high technology company that depends on innovation, a competitor company may easily supplant the company with a better and cheaper solution to their current tests. * Competition: A major downside is the strong competition in the industry, which may impact on their profit margins. Some of their bigger competitors might come up with similar tests and therefore, reduce their advantage over them. * Pricing Pressure: Healthcare is highly regulated, that can force changes in reimbursements by insurance and other third parties. This may directly affect their prices and profitability. * Acquisition Integration Risks: Since most of their growth comes from acquisitions, they may face issues such as integration risks, and may not be able to get the full intended value from these acquisitions. * Dependence on Key Personnel: Their dependency on some specific people and a few high skilled scientists or engineers may lead to an inability to continue developing their new tests, in case some of their star personnel depart.

Understandability Rating: 3/5

Justification: Although not overly complex to understand, it might take time to fully grasp all their product offerings and their underlying technology. The financials require some understanding to analyse the various items related to acquisitions and intangibles. Hence, this is not straightforward enough for a beginner.
It requires a moderate level of knowledge in biology, medicine, and genomics/proteomics to assess their products effectively.

Balance Sheet Health Rating: 3/5

Justification: VCYT’s balance sheet is not overly strong. The company has a moderate level of debt and cash. But a positive thing is that the company is showing positive growth in revenue, and is slowly showing improvement in other financial metrics. The company will need to improve its liquidity to make it a better and more reliable investment.
While debt is a small part of their capital structure, it is still not the most ideal situation since this needs to be repaid and takes away from their future profits.
Cash and cash equivalents were $193 million as of September 30, 2023, compared to $219 million as of December 31, 2022. It indicates that the company is quickly burning cash to sustain and grow their operations.